Take account of the constraints on your business

The most appropriate strategy will depend on how you want to position the product

In many markets, a high price contributes to the perception of a product as being of premium value.

You may want to establish consistent pricing across your product range, or use pricing to position your products at different levels.

Different strategies may be appropriate at different stages in the product’s life cycle.

You can charge higher prices if high barriers to entry prevent new competition

For example, if you have a patent, special skills or strong customer loyalty.

Customers will be more loyal if purchasing an unsatisfactory alternative carries significant risk to them.

You may want to limit your prices

If barriers to entry are low, low prices avoid encouraging new entrants.

You may need low prices to introduce a new product to a new market, or if you face intense competition.

You may want to use low prices as a tactic, for example when demand is seasonally low or to offer bulk or trade discounts.

You should always aim to keep your prices high enough above your costs to at least break even.

You may want to charge different prices for different customers

Customers who purchase repeatedly, or buy add-on or related products, are the most valuable.

Customers who are expensive to satisfy (e.g. demanding special features or service) will be less profitable, unless you can charge them higher prices.

One-off sales generally carry far higher costs than repeat business.

3. Your costs

Work out your cost structure

Variable or direct costs are linked to volume - the more you manufacture, the higher the cost. These include raw materials, electricity, packaging and distribution charges.

Fixed or overhead costs remain constant regardless of volume. Fixed costs typically include premises costs, administrative overheads and salaries (though wages will increase if you have to pay overtime for rush orders).

Make sure you take into account all your costs. For example, research and development costs for new products.

Analysing your costs tells you what prices are viable

If you charge less than your direct variable costs, you will make a loss.

If you charge more than your direct costs, each sale will make a contribution towards covering your fixed costs and ultimately making a profit.

The contribution each sale makes towards covering your fixed costs tells you what volume you need to sell to reach break even.

Your cost structure may influence your strategy

If you have high costs relative to your competitors, you will need to position your product with a premium price.

The higher the proportion of fixed costs, the more important it will be to generate high sales volumes.

Some costs are unrecoverable if sales are not made soon enough. For example, if products are perishable or become obsolete.

Basing your prices on your costs has major disadvantages

Cost-plus pricing, which involves adding mark-up to breakeven, is common but does not take into account the level of demand and competition.

Cost-plus pricing ignores brand image and market position. When you want to create the perception of a high-quality brand, the price needs to reflect this.

The price you need to charge depends on the volume you sell, which in turn will depend on the price you charge.

If you fail to include all your costs in your analysis, you will end up undercharging. It is easy to overlook hidden costs such as wastage, holiday pay and depreciation.

Analysing costs and margins can be a useful benchmarking exercise

In the absence of other reasons, margins below industry norms suggest your costs are too high or your prices too low.

Industry margins provide a rough guide to the prices which may be achievable when considering new products.

Differences in costs can be a useful way of creating consistent pricing across a range of products or markets.

Low-margin, low-volume products should not occupy large chunks of your time or storage space at the expense of higher-margin products.

Analysing the additional costs can help to prevent you from undercharging for special orders or for demanding customers.

Boosting profits

Look for ways to provide something customers are willing to pay for

For example:

Convenience. A late-night convenience store can charge much more than a supermarket for a pint of milk.

Brand. There may be little to choose in technical terms between a branded and an unbranded product, but big spenders will go for the expensive product if the brand is well marketed.

Fashion. Some people will pay a premium for trend items (e.g. the latest trainers or cars).

Uniqueness. If you are the exclusive supplier of a product or service, you can set your own prices.

Scarcity. Tickets for top-level sports events can be highly priced as there will be more committed potential customers than available seats. Higher prices can give you fat profits, but may also alienate customers and draw in new competitors.

Look at other ways to increase profits

Would more marketing muscle help? Would sales rise if you increased prices by 5% and spent the extra revenue on promotional activity and improved customer care?

Can you reduce variable costs? Are there cheaper supplies elsewhere or would existing suppliers be prepared to drop their prices?

Can fixed costs be pared down? What could you negotiate?

Should you alter your product mix? If you cannot make enough profit on a product, consider dropping it.

4. Tactics

charging lower prices for high-profile products to capture customers who will also buy higher margin products;

charging different prices at different times of the day, week or year to reflect changing demand or the changing value to customers of your product;

charging different prices for different levels of service or product specification.

Discounting can be worthwhile, but only if it achieves your aims

If you offer discounts make it clear they are one-offs or short term. Discounting too often can lead customers to question your usual prices.

A cash payment discount can encourage early payment, though some customers may claim the discount but delay payment anyway.

Bulk discounts can encourage larger orders. The costs of dealing with large orders may be little higher than for much smaller, less profitable orders.

Clearance discounts can help you sell off old stock and release working capital.

Retrospective discounts or rebates may encourage customers to concentrate their purchases with you.

Introductory discounts may encourage customers to try a new product. However, they may create the wrong image or generate sales which are not repeated when the discount is removed. They can also cause resentment among current customers.

Special tactics may work in particular situations

For example:

Bundling additional products together and charging a package price. This works well if the perceived increase in value is greater than the additional costs.

Charging a psychologically attractive price. For example, £7.99 can be perceived as being more than a penny less than £8.00. Make sure you have a plan to increase from this price point or you may be stuck with it forever.

5. Checking your prices

Review your prices regularly to ensure they are optimal.

Keep up to date with the market

What is the competition doing?

How are customers’ perceptions of the value of your product and competing products changing?

What effect is any change in your costs having on your margins?

Changes in turnover may indicate a pricing problem or opportunity

Products with high or growing market share may present an opportunity to increase prices.

If you pitch or tender for business, too high a success rate suggests that you are underpricing.

If both margins and market share are low, you need to change something - or discontinue the product.